Over at Catallaxy, Sinclair Davidson suggests that reductions in carbon emissions should be financed by bonds maturing in 2050, so that the cost is borne by the future beneficiaries[1]. He ends with what is presumably intended as a snark
The real question is how these bonds should be priced? As an opening bid I reckon the ridiculously low discount rate proposed by the Stern Review should be used.
Looking up the latest data, 30-year US government bonds, the closest approximation to a 2050 maturity, are yielding 4.25 per cent. Assuming the Fed manages to hit the midpoint of its 2-3 per cent comfort zone for inflation, that’s a real interest rate of 1.75 per cent. That’s about typical in historical terms – the long run real bond rate has mostly been between 1 and 2 per cent.. Stern doesn’t propose an exact interest rate, but on standard parameters, his proposals imply a real rate of around 2.1 per cent. So, if Stern is ridiculously low, the market bond rate must be positively insane. Perhaps the Catallaxy crew can come up with some libertarian proposals to raise interest rates to a more sensible level.
Update The title was meant as a snark, but in an update, Davidson asserts that “we all know” that the rate of interest on US 30-year bonds is too low. He links to a piece on monetary policy in the mid 2000s, but, as I pointed out above, the current real interest rate is close to the average for the last 120 years. So, Catallaxy really doesn’t like bond markets.
To expand a bit on this point, there is a large literature suggesting that, because of capital market failures, the average rate of return to equity is too high, and the real bond rate is too low. Simon Grant and I have done a lot of work on this issue, and its implications, such as the fact that privatisation is often undesirable. However, correcting the market failure would only raise the bond rate to levels consistent with Stern’s estimates (there’s room to fiddle a bit with the parameters, but Stern’s default choices are pretty plausible).End update
fn1. He includes a suggestion that the bonds should be contingent on exact forecasts of economic environmental outcomes at that date, but I’ll pass over this in silence.
John Quiggin 
Not economic forecasts – environmental outcomes.
Honestly Sinclair, concede defeat and get on with it.
Denying that carbon emissions is influencing climate is just so unscientific.
Does it really count as silence if you mention it? 😉
“He includes a suggestion that the bonds should be contingent on exact forecasts of economic environmental outcomes at that date, but I’ll pass over this in silence.”
I suppose silence is the polite response. But I don’t believe politeness dominates even from a purely Finance perspective. Bonds are not suitable financial instruments for state contingent contracts. Evidence: The CDO component of the current financial crisis, junk bond crisis, … going back in time.
A nice feature of some of these financial instruments, for the seller, is that if the bad thing happens, it is so catastrophic that your company collapses, and you don’t have to pay out in full, if at all. Meanwhile, you retire on your commissions, and bonuses. I suppose that is why insurance companies don’t insure against certain things. Of course, insurance is heavily regulated and the question of whether there were things that insurance companies can not really insure against was determined in a climate with a bit more business morality than evidenced nowadays — back in the days when we were all socialists. Some financial instruments, like CDSs for example, were invented to get around having to comply with the regulation governing the insurance industry. Nothing like innovation.
I am offering to insure anyone, at very reasonable yearly rates, against the extinction of the human race. Any takers?
If you get in quick, I will sell you two ‘extinction of the human race’ policies for the price of one. Offer ends end of February.
Once upon a time government bonds were supposed to be safe, long term and a relatively risk free way to save and your grandafther may have owned a few……what went wrong?
Does the Fed have a 2-3 per cent inflation target? The RBA does, of course, but I’ve not heard of the Fed having it.
Highly germane – Garnaut’s first of a series of eight updates to his 2008 work.
With a summary/discussion area here are LP.
Now I’m certainly not qualified to comment on the relative merits of Davidson versus Garnaut as professional economists, I will merely observe that Garnaut seems to be extremely well regarded and highly influential in the real world of commerce and trade.
The economic problem with Cattalaxy’s bonds is that he describes them as “a long-lived debt instrument – probably a zero-coupon bond matched by a sinking fund that is financed out of all the economic prosperity generated by the transition to a greener economy. Of course, if the economic prosperity doesn’t eventuate the bondholders will lose their investment. ”
I don’t think I’m unusually pessimistic in saying that us “warmists” aren’t resting our case on improved prosperity; we’re saying just saying that if we act there will be fewer ghastly catastrophes than there otherwise would have been. I’d foresee more and larger floods and cyclones destroying actual economic production units and lowering GNP, as we have seen, but fewer floods and fires than under the four degrees rise scenario.
As in war, large expenditures bring you nothing except survival.
There may conceivably be economic benefits, but they’re not the point of the exercise.
The ethical problem might perhaps be seen as the comment that “I believe the beneficiaries of the policy should pay the bulk of the costs – that means future generations and those who would be more likely to be more adversely affected by AGW. So I would not envisage a wealth transfer from currently rich nations to currently poor nations, rather a transfer from …..” on that principle, surely, from currently poor nations to currently rich nations. He in fact segues to “rather a transfer from the future to the present” but that doesn’t seem to affect the other branch of his argument: “future generations” should pay, certainly, but so on the same grounds should “those [such as Bangladeshis, I presume] who would be more likely to be more adversely affected by AGW”.
Which does seem to be adding insult to injury.
It’s not future generations that are the beneficiaries of climate policies but current generations who are the beneficiaries of a market failure that doesn’t include significant and accumulating costs. It’s like a kind of debt with compounding interest and there is no way to write that debt off with clever accounting and shifting capital around, it’s coming our of our capital; the environmental capital that will be lost will be permanently lost. Future generations are not going to be beneficiaries of our climate policies they are going to be victims of our lack of climate policies.
Fran, no surprise you get a non-solution from people who insist climate change is a non-problem.
@ChrisB
This is an important point. This is damage control. If the programs are successful (and this implies coherent action lasting several decades on a world scale than the benefits will show up in a reduction in the scale and frequency of disasters, premature morbidity etc. Most prediction assume that the removal of fossil hydrocarbons and the imposition of costs will knock the top off growth on a world scale in a minor way — which is not to say that some states won’t actually do better than they would have otherwise.
Of course, the world still grows in GDP terms, just not quite as quickly.
Update:
If we all know that the long run bond rate in the US is too low, surely, according to market worship theory, we can all make money shorting the bonds. Isn’t every market error, which we know only exist as theoretical possibilities, an opportunity for risk-free profit taking? Isn’t that why they never occur? I am surprised by the Davidson heresy! My faith in that brand of economics is now severely shaken. If not stirred.
@Uncle Milton
US Fed is said to have a “comfort zone” rather than a target. It’s commonly said to be 1-2 per cent for core PCE, but the exclusions from the core (food and energy) mean it has typically corresponded to 2-3 per cent CPI inflation over the past 20 years or so.
Is this completely weird? (eg) How would you know that the bonds had worked and how would you know how much they worked? If you can’t agree now, even on the basic science, let alone the economic implications or the accounting methodology, how could you possibly expect some other people to agree in the future? Maybe, they’ll have grown up by then?
This sounds more like a fanciful way of exporting the the embarrassingly crazy libertarian position on AGW into the hazy distant future. Someone else’s problem at some other time. Nothing’s changed.
As far as I can make out the Catallaxian default position is that they begrudgingly accept that the scientists may be right on AGW but nothing, absolutely nothing should be done that may impede the economy. In that way the future generations will have abundant wealth to mitigate the effects of climate change, if any.
To my mind that amounts to a bet and as most gamblers can attest, the track always wins.